Formation Of Indonesia Economic Policy Uncertainty Index For 2014-2021

Universitas Indonesia

Abstrak

Background Study The information contained in newspapers is one of the factors that
determine decision making at the individual level or on a larger scale.
We’re trying to exploit information contained in newspaper to create a
proxy to measure uncertainties.

Research Aims This study aims to form an index of uncertainty in economic policy for
Indonesia during the period 2014-2021, as previously done by Baker,
Bloom Davis (2016).

Introduction of method The index will be built by analyzing the big data collection of selected
newspaper articles for the period January 2014-December 2021 using
text-mining analysis which is then quantified based on the frequency of
Indonesian-language newspaper articles containing terms related to the
economy, policy issues, and uncertainty/uncertainty.
Major result finding The index that will be built hopefully can shows off volatility happen
for the past 7 years in Indonesia

Conclusion We will use this measure to understand the effects of policy uncertainty
on firm stock level price volatility and also the spill-over effects of
policy uncertainty happened in other countries to Indonesia.

Implication By developing the EPU Indonesia index, we hope to deepen

understanding of broad economic, political and historical developments
through systematic empirical enquiries
Introduction

Introduce the subjects Uncertainty is defined as an epistemic condition (knowledge) which

includes imperfect or unknown information. Uncertainty is a vague
concept, because it reflects uncertainty in the minds of consumers,
managers and policy makers about future events, and is also a broad concept
and includes both macro and micro phenomena (Ahir et al., 2020). In
Layman's terms, it can be said that 2020 and 2021 are filled with conditions
that cause uncertainty; Elections in the United States, Brexit in the United
Kingdom, and those that are not finalized until mid-2021; the spread of the
Covid-19 virus.

Introduce the subjects Several parties have attempted to use various methods to create a proxy
(advance) index to explain policy uncertainty and analyze the relationship between
market movements and policy uncertainty; both with an approach based on
the volatility of the main economic and financial variables (Leahy and
Whited 1996; Bloom 2009). One of the most widely used is the Market
Volatility Index (VIX) from the Chicago Board Options Exchange (CBOE)
as a proxy for uncertainty in the stock market. However, the weakness of
the VIX is that it only captures uncertainty in the stock market – which
depends on the liquidity and depth of the stock market, so the VIX can only
be relied on in mature markets and industries and is not easy to replicate in
other countries. There is also a news-based NVIX index issued by the Wall
Street Journal (Manela & Moreira, 2017) and the FEARS Index which
measures uncertainty based on investor sentiment and fear based on text
data from internet searches (Da, Engelberd, & Gao, 2014).

Position of the subject in Recently, what is being frequently quoted is the EPU – Economic Policy
the research Uncertainty Index (hereinafter referred to as the “EPU index”) proposed by
Baker et al. (2016). The EPU Index was formed to measure the uncertainty
of national economic policies based on the relative frequency of articles in
national newspapers containing at least one of three terms related to
Economy (E), Policy (P) and Uncertainty (U) and depending on the
frequency. Reports in the countries observed can be daily, monthly, or
quarterly.

Importance of the From previous studies, it was found that uncertainty has a major impact on
research investment growth as well as volatility in the economy and financial
markets, therefore there have been many attempts to establish uncertainty
proxies to help investors and regulators in decision making

Recent status of the To the author's knowledge, to date there are 26 countries that already have
research an EPU inde, 1 Global Index, as well as several categorical and other indices
based on the EPU methodology.

Findings of the latest The EPU index is especially helpful for looking at uncertainty in countries
research with limited alternative uncertainty calculations – as long as there is a
 newspaper distribution in that country. In addition, the EPU Index is "real
time" and "forward looking" and can be used as one of the components of
calculating leading indicators of the economy.

Novelties (newness) While several authors have conducted research on the spillover effect of
the Global EPU index and other countries on Indonesia, to the author’s
knowlegde, no one has already build an EPU Index for Indonesia during
2014-2021.
The objectives This EPU Indonesia’s index formulation will capture the current state of
economic uncertainty from time to time. Thus, it is hoped that the
establishment of the Indonesian Economic Policy Uncertainty Index as one
of the leading indicators of the economy can then become the basis for
further research, especially in the context of policy formation in Indonesia
and also investment decisions by investors.

Literature Review
The Efficient Market Hypothesis (EMH) is the idea that stocks reflect all available information.
EMH argues that the market is efficient and leaves no room for investors to create excess profits by
investing while everything has been assessed fairly and accurately and the only way for investors to get
higher returns is to invest in riskier assets.
The idea of EMH itself is still being disputed, with examples such as Warren Buffet making a profit
from buying undervalued stocks but are willing to gather information and perform analysis. Grossman &
Stiglitz (1980) argue that investors will have an incentive to spend time and resources analyzing and
uncovering new information only if the activity is capable of generating higher returns. Therefore, in a
market equilibrium, efficient information gathering activities will be able to deliver results.
Given the importance of the impact of uncertainty on the investment and spending decisions of
governments, firms, and households, many researchers have therefore sought to identify measures of
uncertainty, particularly those related to economic policy – the aim is to use these indicators to capture
trends in fluctuations. One of the most well known is the standard deviation of stock prices and stock
returns. The Market Volatility Index (VIX) of the Chicago Board Options Exchange (CBOE) has been used
for years as a proxy for uncertainty in the stock market. However, the weakness of the VIX as a market
measuring tool is that it only captures uncertainty in the market – which depends on the liquidity and depth
of the market, so the VIX can only be relied on in mature markets and industries and is not easy to replicate
in other countries.
In addition to the VIX by CBOE, Manela & Moreira (2017) formed the NVIX index which is a
news-based uncertainty index issued by the Wall Street Journal (WSJ), however, this index only captures
the news component of uncertainty.
Da, Engelberd, & Gao (2014) established the FEARS index, which measures uncertainty based on
investor sentiment and fear based on text data from internet searches.
Baker et al. (2016) in the formation of the EPU index captures uncertainty in news, policies,
markets, and economic indicators. The EPU Index averages three things; the level of newspaper coverage
of policy-related economic uncertainty, how much of the federal tax code provisions will expire, and
disagreement among economic forecasts – particularly for the formation of the EPU Index from the United
States, while globally based solely on newspaper coverage levels.
Gentzkow & Shapiro (2010) established a media bias index to measure the language similarity of
news outlets to Republican or Democratic congressmen.
 Hoberg & Phillips (2010) used a text-based analysis of 10-K product descriptions to examine
whether firms exploit product market synergies through asset complementarity in mergers and acquisitions.
Boudoukh et al. (2019) uses textual analysis to identify relevant public information news related to
certain company events and shows that company-level public news is a meaningful component of stock
return variance.
Alexopolous & Cohen (2015) created a text-based indicator of general economic and policy-related
uncertainty from the New York Times and showed that uncertainty shocks – both general and policy related
– depress levels of economic activity, increase stock market volatility, and decrease market returns.
Bernanke (1983) states that a high degree of uncertainty provides incentives for firms to delay
investment and recruitment when project investments are too expensive to redo or workers are too
expensive to recruit and then lay off. Pindyck (1991) states the importance of the implications of investment
irreversibility, where investment is sensitive to various forms of risk including the risk of uncertainty; future
product prices, future interest rates, and operating costs, as well as investment costs and timing – the
irreversibility of which then has implications for macroeconomic policies.
William (2013) and Baker et al (2015) argue that increased uncertainty contributes to a deep
recession as well as a slow recovery.
Gilchrist et al. (2014) indicate that financial friction is a strong channel through which shocks from
uncertainty affect aggregate investment. The spike in uncertainty leads to capital liquidity shocks and can
be a source of macroeconomic fluctuations. Pastor et al (2013) stated that uncertainty has an effect on
reducing household spending on prevention activities as well as upward pressure on financial costs
Panousi & Papanikolaou (2012) argue that managerial risk aversion induces a negative relationship
between idiosyncratic volatility and investment. Managers tend to reduce investment when uncertainty
about the company's future prospects increases, even though the uncertainty is company-specific.
Basu & Bundick (2014) show that an increase in uncertainty has a greater negative effect on the
economy, especially if the monetary authority is limited by a minimum nominal interest rate of 0% as
happened in the 2008 crisis.
Friedman (1968), Rodrik (1991), Higgs (1997) and Hassett & Metcalf (1999) consider the
detrimental effect on the economy of uncertain monetary, fiscal and regulatory policies.
Rodrik (1968) in his writings points out that moderate policy uncertainty can weigh on investment,
and sound reforms, if they raise doubts about their permanence, can be destructive.
Higgs (1997) stated that the occurrence of insufficient private investment in the period 1935-1940
reflected uncertainty among investors regarding the security of their capital property rights and the
prospects for returns.
Hasset & Metcalf (1999) discuss uncertainty in tax policy, where increasing uncertainty slows
down investment.
Born & Pfeifer (2014) studied the risk of policy uncertainty in the business cycle and Fernandez-
Villaverde et al. (2015) find unexpected changes in fiscal volatility shocks can have a sizeable detrimental
effect on economic activity.
Pastor and Veronesi (2013) argue that political uncertainty reduces the value of the government's
implicit put protection to the market. It also makes stocks more volatile and more correlated, especially
when the economy is weak
Research methodology
Based on the author's consideration, the selection of newspapers was mainly related to the use of
the written language used (Indonesian), the distribution of newspapers nationally, the frequency of
publication and the availability of article data since the 2014 period. The following are some newspapers
which were then selected based on these criteria; 1. Bisnis Indonesia, Daily Cash, Daily Seputar Indonesia,
Investor Daily Indonesia, Kompas, Media Indonesia.
The articles used come from print media in digital form, where the news produced is usually more
comprehensive than news from digital media and can cover a wider time span.
Based on research that has been done by Baker et al. (2016) articles which then have the value of
EPU = 1 are articles in which there are the following three categories of terms;
Table 1. Categories of terms searched in articles
Economic Ekonomi
Policy* Defisit, Peraturan, Regulasi, Pemerintah,
Kementerian Keuangan, Bank Indonesia
Uncertainty Ketidakpastian, ketidaktentuan

Especially for the “Policy” category, periodic simple audits are conducted where further
information and testing is needed in order to produce a set of terms that can capture conditions more
comprehensively. From this it is expected to produce raw data on the total volume of articles across
newspapers and over time
The period of research data is daily data for the period January 2014 to December 2021. The
selection of the time period is adjusted to the availability of data and events that occur in it.
Then a calculation scale is formed based on the total number of articles in the same newspaper and
month, which results in a monthly EPU series for each newspaper. On this scale, standardization was carried
out at the level of the newspaper series to form a standard deviation throughout the study period and the
average was calculated between newspapers on a monthly basis and normalized the six newspaper series
with an average value of 100 throughout the study period.
The index is then adjusted to the current conditions in the time series to see the impact of economic
uncertainty on these conditions, as stated previously
To test the robustness of the index formed, it is planned to do 3 ways; 1) Manual audit by testing
research samples by forming a special team under supervision to conduct testing and codification of sample
articles during the research period. In testing based on specific guidelines that have been established by the
initial research team. In this test, a re-test of policy-related terms that often appear in newspapers related to
economic uncertainty is also carried out. 2) Comparing with the existing EPU index to test the spillover
effect, from the IEPU index, a correlation test is also carried out between the EPU index that will be
generated. with the global EPU index and other countries that have a fairly close economic relationship
with Indonesia 3) Comparing with daily stock price movements, especially for movements above 2.5%.
then matched with articles related to economic uncertainty that discuss the movement of these stocks. The
explanation of the movement is then recorded, and classified whether it is related to the policy or not
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